Thursday, 28 April 2011

If I read these news correctly, the head of Portuguese bank BPI (one of the four largest) has admitted that his bank holds: 2.7bn of Portuguese bonds and 0.5bn of Greek bonds.

Wow!

This in total financial assets of about 10bn, and in total assets of 44bn. (According to here). And, most important of all, with shareholder equity of 1.9bn and own funds of 2.8bn.

Double wow!

Now you know why BPI's chairman, Fernando Ulrich, shows up with a new statement in the press about public finances, macropolicy, and the government almost daily for the past few months. His fate is on the line...

Today's Financial times published a letter from me and Luis Garicano. It is pasted below:

Sir, The European Union’s urge to have the main Portuguese parties sign a comprehensive rescue plan before the general election (report, April 19) is misguided, as it affronts democratic values and provides an opening for populist parties to rise. International institutions must learn the lessons from Ireland’s rescue, including showing respect for the political process. It would suffice to have a two-month bridge loan that comes due very soon after the election, at a punitive interest rate, coupled with a written commitment from the main parties to hit a multi-year deficit target. The Portuguese could then choose what mix of higher taxes and lower spending they want when casting their votes in the election. Paying an interest rate close to the current market values on a two-month loan is a cost the Portuguese should be willing to pay to keep their right to vote, and the EU’s rescue plan would gain legitimacy and a lower risk of future renegotiation.

Monday, 25 April 2011

One puzzling aspect of the public debate in Portugal is the considerable disagreement about key parameters of the economy. There are widely different views across (and sometimes within) the political spectrum on major questions such as the optimal size of the public sector, the link between minimum wages and employment, the importance of state-owned firms, the degree of employment protection, the importance of low public deficits, teacher evaluation and many other issues. This stands in considerable contrast with other Western countries, where the benefits from flexible markets are acknowledged by most and the public debate tends to be focused on relatively minor issues.

It is true that these disagreements in Portugal are not that relevant these days: given the slow growth of the last 10-15 years and the current huge debt levels, several reforms are most likely going to be imposed from abroad anyway. However, the sustainability of such reforms may be at stake if many in the country find them at odds with their own views of the economy. It may even be that the legality of those changes would be successfully challenged, for instance at the Constitutional Court, and subsequently reversed. In any case, the introduction of the reforms would be much more straightforward if a persuasive case could be made of their importance and fit with the parameters of the economy.

So why are there so many contrasting views of the Portuguese economy in the country? Is this because the Portuguese democracy is relatively young and more time is needed for public opinion to converge on a more restricted range of parameters? A recent paper by Gilles Saint-Paul - on occupational choice and the political economy of reform - offers some possible answers, based on two views of F. Hayek on the role of the intellectuals. First, there is a selection bias in occupational choices: talented pro-market people prefer business sector jobs, while talented anti-market people prefer intellectual professions (as these tend to be sheltered from the market, which is regarded as unfair). Second, the nature of the intellectual occupations (e.g. teachers and professors in the public sector) is such that they insulate the people that take them from the reality of the market - if the market is regarded as unfair or wrong in some way, then those occupations would want to follow a different framework.

If this approach is appropriate for Portugal, then the April 25th revolution - despite its major achievements - probably played a large role in the current status quo of very heterogeneous views of the structure of the economy. Many new intellectual occupations opened up after 1974 as the welfare state expanded and most of them were taken by those with anti-market views (which were popular at the time). In this case, time by itself will not necessarily promote a significantly better understanding of the parameters of the economy in Portugal. However, one way forward may be a changing, more open-minded nature of the intellectual occupations. A general acknowledgement of the great advantages of analyses based on representative empirical data - rather than subjective views or simply the clichés from the past - would also be a step forward.

Tuesday, 19 April 2011

Recently, Robert Fishman has contested the need for a request of help from international partners by the Portuguese Government.

Although there are some elements of truth in his arguments, such as the role of rating agencies,

the underlying prospects for growth were not as good as he assumes. The growing trade deficit is also an important issue and reflects the inbalances of the Portuguese economy. I will not elaborate further on this, as other posts in this blog have already discussed it.

Instead, I want to focus on another possibility that has been voiced: an interim loan, until the new Government coming out of the elections is able to negotiate the full international loan.

I actually prefer that current political forces do it now. One reason is for democratic judgement in the elections. If they are forced to agree now on the path to be followed, then electoral campaign can be done more substantive issues, and not on blame, and no party, whoever wins, will need to contradict the speech used a couple of days before. In times of difficulty, increasing the lack of trust on the political leaders of the country just seems unreasonable (to save on stronger words...)

Second reason, if the parties are forced to agree now on measures, they will probably agree on a more coherent set of measures. They do not know who is going to lead the new Government, so finding a common ground in the negotiations with lenders is probably easier. Moreover, lobbying efforts from affected sectors need to be dispersed across the relevant parties, and do not concentrate on the winning side.

My colleague António Pinto Barbosa, expert in political economy and "constitutional economics", called this a decision under the Rawlsian veil of ignorance. Actually, thinking about, it seems to be a good occasion for a practical application of these ideas.

So, the demand (more than request) to political forces must be: do it now, do it before the elections!

Monday, 18 April 2011

Interesting post by the BBC business editor, making the case that it is in Germany's interest to adopt a softer stance on the bailout terms. Given the exposure of German banks to the three countries, moral hazard problems should probably be addressed some other time lest these countries default now.

Friday, 15 April 2011

The problem with the quick missions to devise a "memorandum of understanding" associated with a bailout in three weeks is that technicians from EC, ECB and IMF are, very often, not aware of the structural problems of the public finances in the particular country they are analysing. On the other hand their main advantage is that they have a fresh look from the outside. Governments and local politicians, who have been benefiting from the status quo, usually do not address these issues. The problems Portugal are facing today, apart from low economic growth which is a different story, lie on these 10 "capital sins": 1- The structure of federalism: central, regional and local governments 2- The measurement of public debt: European criteria and Eurostat rules. 3- The evolving structure of Central Government Administrations: the autonomous funds and services. 4- The spin-off of general government institutions: the new public sector “enterprises” 5- The Public-Private partnerships: decision-making and accountability 6- The non implementation of a control cost mechanism on Health expenditures. 7- The “bottom up” budgetary process and the Ministry of Finance. 8- The high proportion of pensioners and the inequality of pensions. 9- The non implementation of existing Constitutional rules to constrain expenditure 10- The excessive partisanship of public sector nominations. As it is clear most of the problems have to do with institutions (either weak or badly designed), so that they will be beyond the scope of EC/ECB/IMF memorandum proposal.

Thursday, 14 April 2011

Why is the German government so worried with the polls? Are they that fragile? That's a shame because, as we all know, European integration depends a lot on Germany. I wonder how an SPD government would act at this venture. Maybe in 2013 we'll know the answer.

Saturday, 9 April 2011

Now that Portugal will have a bailout it is important to understand, what can be labeled as the ten capital sins of Portuguese Public Finances from a politico-economic perspective. This small essay (provided here as times goes by) may be of interest to several groups of people. The technical experts of the institutions that will negotiate with Portugal the bailout (mainly from the European Commission, The European Central Bank and the International Monetary Fund); the European politicians that lead the EU, those who have worked out the revisions to the Stability and Growth Pact (SGP) and those who are now redesigning the European Stabilization Fund ; the Portuguese citizens who will mostly suffer from the mismanagement of public finances, in particular the young generations who will pay the major part of the bill; economic journalists; and last but not least the Portuguese politicians who will run Portugal (and those who will stay in opposition) after the 5th of June general election .As will become apparent some of the "sins" have developed in close connection with the structure of incentives embodied in European rules. Others are more idiosyncratic. The interest in presenting them is that although they are specifically Portuguese, and should be taken into account by different “stakeholders”, they exist in slightly different forms in several Europeans countries. So what some of them reveal is the urgent need for reforms at an European level.

The order of presentation will not be the sequence of relevance and all comments will be welcome. The timing of writing is uncertain, but I will try (not promise!) one or two contributions per week.

PS Some economists disregard the problem of public finances saying that the problem of Portugal is lack of economic growth and that having the latter the former will be solved. We all know that there is a relationship between the nominal growth rate, and the deficit-to GDP ratio that sustains a constant debt-to-GDP ratio. When the Stability and Growth Pact was designed, politicians assumed European economies will grow nominally on average at 5% so that a deficit ratio of 3% will keep the debt ratio at 60%. Although it is obviously truth that growth really matters, the argument that deficit and debt are just a byproduct of other issues is not only fallacious but also dangerous. As we will show the mismanagement of Public Finances in Portugal is a consequence of several structural problems, the sources of which are independent from economic growth. If these problems are not solved, they will impair economic growth, ie they will have a counter-effect on any measures taken to improve growth. That is why it is dangerous to disregard them.

Friday, 8 April 2011

History does not repeat itself, but in Portugal it certainly rhymes. It's easy to say now that the request for foreign aid made yesterday by the Prime Minister was the inevitable outcome of the accumulated stress of the last two years. But during that time the government, the European Commission and even the IMF sought to persuade us that the Portuguese case was different from the Greek and then the Irish. There might be merit in this differentiation, but sometimes it's useful to compare the present with our own past, even if distant. A quarter century of European integration and ten years of Euro membership were enough to convince us that Portugal had 'graduated' in the class of nations, leaving behind a past of financial and currency instability. The dreaded return of the IMF (or EFSF, as the President insists) re-evokes the memories of 1978 and 1984, but in my opinion the past that best rhymes with the present is the late nineteenth century. I speak, of course, of the crisis of 1890-92, which culminated in the last Portuguese bankruptcy. The parallels are striking and instructive.

For the most forgetful among you here's a brief recap. The problems began in April 1890 when the government had trouble placing a loan in Paris. A banking crisis followed in September with a run on the Montepio Geral, which was saved by the Bank of Portugal. Meanwhile, the current account took a wrong turn by the fall in the remittances from emigrants in Brazil. Despite the guarantees (avais) given by the Bank of Portugal and the government to a number of banks and railway companies, heavily indebted abroad, capital started flowing out of the country. Until 1892 the government committed about 12% of total public expenditure to these guarantees to not much avail. In November, the house of Barings, one of the most reputable London bankers, went bankrupt under the weight of its exposure to Argentinean debt (Argentina had defaulted in June). This precipitated a financial crisis worldwide, with capital drying up to peripheral nations such as Portugal. To make matters worse, Barings was the main external agent of the Portuguese government, and its failure cut off the access of Portugal to critical short-term credit. 1891 opened up with a failed republican uprising in Porto and, more importantly, with the bankruptcy of the Banco Lusitano, which the authorities were impotent to prevent. The Bank of Portugal itself had dried up its sources of credit and was in trouble to make up on the debt raised the year before. Under a situation of renewed capital flight (gold), and the threat of a banking collapse the government responded, in May, with a moratorium of 60 days and the suspension of convertibility in gold. By the end of June the currency had lost 6% of its value, adding up to more than a quarter until December. In the second half of 1891 the government negotiated a 'bridge financing' of £6.4 million, in exchange for the 35 year monopoly of the production and sale of tobacco to a group of domestic and foreign investors. Finally, in January 1892, Oliveira Martins (another Northerner at the finance ministry) decreed the suspension of debt payments in gold and began negotiations with foreign creditors. These were quickly interrupted, on 13 June 1892, by a change of government and the imposition of a partial default on the external debt.

Now replace Montepio and Lusitano with BPN and BPP; the railway companies with Refer and the Lisbon and Porto subways; tobacco with the pension funds of PT and the Social Security; and the Barings case with the current fears of exposure of European banks to the 'PIGS' and the story begins to sound like déjà vu. Today, as 120 years ago, the structural imbalance of the current account, particularly in the context of exchange rate stability, brought about an excessive foreign debt under the guarantee (directly or implicit) of the Portuguese state and the inevitable failure to honor the debt service.

There are, to be sure, important differences. Even though the abandonment of the gold standard was perceived to carry severe reputational costs, it was much easier to organize than the putative opting out of the Euro. It also helped that back then the external indebtment was mostly a sovereign affair, compared to today. Although it is hard to reconstitute the magnitudes, my own research suggests that the level of external debt just before the default represented about 40% of GDP, 35% of which government owed. These figures are in strike contrast with the statistics quoted here earlier by Ricardo Cabral. Despite their many design flaws, a network of European and international institutions (EFSF, IMF, ECB) form today a guarantee against an immediate dry up of financing to the Portuguese economy, which would result in a banking meltdown and a painful current account reversal – particularly under the no devaluation option. I agree with everyone who has rejected here the option of leaving the Euro, given the devastating balance sheet effects it would entail, but I also believe that Portugal, Greece, and Ireland should demand a better deal than what has been on offer. Adding up to the high interest charged by the EFSF to Greece and Ireland, the recent reference of Trichet to the peripheral nations as the 'collateral damage' of the fight against inflation in the Eurozone and yesterday's rise of the ECB rate are disturbing. I hope Trichet is playing Janus: indulging the inflation hawks while keeping the floodgates open to the banks.

Thursday, 7 April 2011

Here is an interesting comparison of the pace of the recent Eurozone sovereign crisis with our own debt crisis of the 1890s. Portuguese troubles started in April 1890 and culminated in January 1892 (21 months). The subprime crisis spread to Europe around October 2008 and by May 2010 Greece had appealed to foreign aid (20 months). There is a also striking similarity between the levels of historical Portuguese spreads up to and after the January 1892 default (green dashed line) and the Greek bailout (blue dashed). By most historical precedent, Greece is clearly bust and will need a debt rescheduling. How about Portugal? Long spreads are still markedly lower than the comparators, although that may be just the time lag from contagion from Greece and Ireland. As we don't have the benefit of the hindsight of the next months this invites speculation. But if Portugal follows the same path of Greece and Ireland, I would bet that we would witness a similar pattern, perhaps more accelerated. Plus ça change?

I find this picture very revealing. It was taken from João Cerejeira's blog. It seems that the private sector has fully readjusted to the new reality. That readjustment was fully achieved in 2009, two years ago. Unfortunately, we do not observe such an adjustment the net borrowing needs of the Public Administration. On the contrary, we only observe a disadjustment.

The electoral campaign is going to start now, so I prefer to make any further considerations on who is to be blamed for.

Hard times ahead - but the alternatives looked even worse, after so many months (years?) of relative inaction.

The key question now for me is whether the painful debt-reducing cuts that will follow will also be complemented by a number of reforms that allow the country to grow its way out of debt, in a sustainable manner. This will require strong moves towards more flexible markets and more efficient institutions that the ruling, protected intelligentsia have always decried.

Wednesday, 6 April 2011

I must confess that I like to find patterns in events and dates.It immediately striked me, then, the coincidence.According to our Minister of Finance, the government of Portugal is now about to call for external financial help.That was increasingly predictable, given the refusal of our banking system to buy any additional public debt and the rise in interest rates (specially today).This cry for help happens precisely 19 years after Portugal joined the exchange rate mechanism of the European Monetary System: 6-April-1992 -- 6-April-2011.

Tuesday, 5 April 2011

I agree with Ricardo Reis. I had argued that the “pheripheral” countries banks should be resolved in a May 2010 column in Vox (and in a paper in 2009). The discussion about privatizing the CGD is not really relevant at this point. The banking system is well on route to be nationalized.

Portugal has to restructure its external debt (see German Economists Open Letter, Eichengreen, Rogoff, Financial Times op-ed, and my contributions at Vox and Expresso,). The reduction in Portugal's external indebtedness has to be sufficiently large. In my view Portugal’s net external indebtedness has to be restructured to well below 25% of GDP (from 85.3% at the end of 2010 plus FDI net external debt). I argued this point in an interview to Expresso. This means both private and public external debt has to be restructured. Banking sector net external debt (of approximately 50% of GDP at the end of 2009) represents a large percentage of Portugal’s net external debt.

Therefore, the country has to quickly create a bank resolution law, as done by England following the financial crisis. The aim of a bank resolution process is to reduce the banking system liabilities to put it in a more sound footing. A by-product of this process is that the banking system net external debt falls to more sustainable levels.

The key to restructuring Portugal’s sovereign debt is through changes in the law (Lei Quadro da Dívida Pública), as suggested in a paper by Bucheit and Gulati (2010). Nearly all of Portugal’s Government debt is sovereign debt governed by Portuguese law and jurisdiction (I am not sure about the conditions of that private placement of debt to the Chinese). After all, the conversion from the Escudo to the Euro was done through law changes.

What we face now in the European Union is not a normal negotiation. It is a negotiation between creditor and debtor countries with an economic value without precedent in the history of the Eurozone and probably in the history of the European Union. At the end of 2009, the non-consolidated net external debt of the Eurozone “pheripheral” countries was €1.3 trillion (gross: €4.2 trillion including Ireland’s IFSC). To this you have to add the external debt of a number of countries in the Eastern Europe block. So, game theory suggests that the incentives for opportunistic behavior between EU partners are huge, because the stakes are simply so large. I argued this point in a recent Vox column.

This is why it is now of outmost importance that Portugal refuse to accept the current “aid” of the EFSF/FMI or the ESM after 2013. This aid will substantially reduce the leverage Portugal has to negotiate with creditor countries if, as expected, it results in a change in the governing law and jurisdiction applicable to a part of Portuguese government debt. These are not aid plans, these are plans put together by creditor countries. In my view, not only are they detrimental to the debtor countries, they are detrimental to the Eurozone and the European Union as a whole (see my column in DN and this Independent.ie analysis that candidly and humorously makes pretty much the same point). There are instruments Portugal can use in the meanwhile to obtain further financing without compromising the conditions of its sovereign debt.

Finally, I agree with Pedro Pita Barros that it would be an error to leave the Euro and I believe the problems in the Eurozone can still be addressed.

The reviews seem, believing on what is stated in their web pages, to be based

on the time delay to get external help, given the call for a general election on June 5, 2011.

Two different views from Portuguese politicians on this.

On the one hand, the statement by the President of Republic that current Government still has enough powers to ask for external help (in case of need), and the statement by the main opposition leader that will support and honor (if they win the elections, of course) an eventual request for external help by the current Government.

On the other hand, current Government officials have been saying they do not have enough power to ask for external help.

How much of this difference in views by politicians influences ratings? Should it? Say, if all parties agree that current Government has enough powers on the ability to seek external help, but it is limited in creating new public expenditure until a new Government enters office, would that lead to a reversal in ratings? if not, then other factors must be driving such harsh cuts in ratings.